Saturday, March 17, 2012

Simple Question about the Bond Market

Given the inevitability of hyper-inflation in the near future, is it a pretty simple piece of advice to almost everyone to stay away from lending at fixed rates? Does this mean that everyone should be leaving bonds and bond-heavy mutual funds for stocks and stock-heavy mutual funds?

I know advice could and probably should be stated in a more sophisticated way, but is this simple advice valid as far as it goes?

6 comments:

If hyper-inflation is inevitable, why are the interest rates on bonds currently so low? Shouldn't that expectation be pushing rates higher?

Are the low interest rates designed to herd us into buying the stocks that their current owners want to unload? Is this how they plan to raise the cash needed to get out of the mess they've created for themselves playing around with derivatives and whatnot?

Always remember, the "smart boys" want to buy low and sell high -- and they're able to do it because the average chump always buys at the top and sells at the low.

O', I would agree with the prediction of inevitable currency correction. However, what exactly will it look like? I have come to the conclusion that it will not be a hyperinflation, at least not as generally defined as the Weimar Republic type.

I have come to the conclusion that we are most likely looking at a sharp one-time inflation followed by a currency revaluation.

Stocks are dangerous in that environment, because companies will be getting a lot poorer and many will fold.

We will all be getting a lot poorer, and the general climate will be deflationary, as all sectors off the economy downsize.

IF we do follow that up with a currency revaluation (to escape the crushing debt), I would expect domestic manufacturing to make a strong comeback, which would be great for stocks.

However, if we do revalue the currency, those with gold would make a killing too.

Who knows when this will all happen? I suspect the upcoming war with Iran will trigger a great many momentous events.

Passive wealth generation in these times is almost an impossibility.

If you have some money to throw around, it might not be a bad time to go all-in on real estate. Housing has already bounced on the leading edge (FL and AZ I know of, at least) and is bottoming elsewhere. I know that if I had a spare million, I would gobble up all the cheap houses right now.

The US$ dollar is probably the crappiest currency going except for all the others. The European Central Bank seems to have got the hang of printing, something the Brits have been going at full bore for a while now, and the Chinese have been doing for years.

In fact, the US Fed seems to be doing what its supposed to be doing, preventing the money supply collapsing while the private sector delevers.

Two critical questions, though: what happens when the private sector stops deleveraging, and when will that happen?

If private sector borrowing begins to grow rapidly, the Fed will have to claw back the money it's printed, by selling assets in the market, or the Government will have to buy back the bonds the Fed holds on its books. Either way, this will drive interest rates up, perhaps sharply, perhaps rapidly, which could drive the economy back into recession but it need not cause inflation.

But if the Fed fails to reverse course, then hyperinflation will be a possibility to worry about.

Bonds, and bond funds, will be destroyed when interest rates start rising.

Lets say you buy a bond with one year to maturity paying 1% interest. You would pay $990 to have $1000 returned. You will always get your $100 back but if interest rates rise to 2% your bond on that same date is only worth $980. This is a simple example. Now lets say it has a term of 10 years, the value drops from $905 today to $819. Take the interest rate to 3% and it's present value is $742. Now if you're a fund using 2x leverage .....